The gold price was down 15–30% in various currencies that we track in 2013, mostly due to investment underpinned by ETF outflows. That obviously had a negative impact on our sector. Now, the gold price has been ..

06 Feb 2014

Many junior miners have an ace up the sleeve, and that is commodity price leverage. Joe Mazumdar, senior mining analyst with Canaccord Genuity, sat down with us to share what he looks for in junior companies with a lot of commodity price leverage. In this interview with The Mining Report, find out why bigger isn't necessarily better when it comes to gold mining projects, and why the market is favoring uranium explorers over producers—for now. Mazumdar also shares names of gold companies with "bite-sized" capital needs from Burkina Faso to California, as well as the apples of his eye in the Athabasca Basin, where management teams with significant track records are heading up promising exploration programs.

The Mining Report: The Toronto Stock Exchange (TSX) global index dropped 50% during the past year. Where is the silver-gold lining in this cloud?

Joe Mazumdar: Financing risk for the junior mining sector was highly elevated, to say the least, in 2013 and remains a source of uncertainty in 2014. To reduce the risk of financing a project, we seek projects that generate double-digit returns in the current pricing environment. We also look for management teams with the technical capacity to not only build and operate a mining project, but also to successfully execute the business plan, which includes permitting the project and attracting good personnel. We want to mitigate the technical and execution risks inherent in a project by selecting these management teams. As senior management cannot mitigate all risks such as geopolitical and financing risk, we seek projects in manageable jurisdictions where the management has appreciable relevant experience. Another key is that the underlying asset requires a manageable or "bite-sized" upfront capital requirement.

To be clear, we tend not be overly attracted to projects with significant production profiles that move the needle for large producers. These projects tend to require significant upfront capital expenditures, which puts one at the extreme end for financing risk, and do not offer the returns that investors are currently seeking. We are interested in projects with smaller annual production profiles (100,000–150,000 ounces [100,000–150,000 oz]) that can interest an intermediate acquirer and provide a decent internal rate of return (IRR). At that level with a good IRR, an intermediate can show growth that would not move the needle for a major, as well as provide a return for its shareholders.

TMR: In terms of financing, exchange-traded funds (ETFs) have negatively affected the positions of shareholders in the mining spaces. Do you see any change in that phenomenon?

JM: Since inception, the ETFs have eroded the premiums of gold mining companies. But most of the erosion has happened among majors and intermediate producers, less so for junior developers and explorers, as they do not actually produce gold and do not attract the same investor base. In the last year, in our analysis of the sensitivities of gold equities to the gold prices, we have certainly seen that the junior sector is best for investors who want high beta to the gold price.

TMR: Let's talk about mergers and acquisitions (M&A), which are always germane to junior mining companies. How are those getting funded in today's financial environment?

JM: As producers have not seen share price depreciation to the extent that juniors have, suitors have tended to finance their M&A transactions predominantly through shares and less so with cash. Some deals include cash as an incentive to make the deal transactable—or to avoid having to go back to the shareholders for a vote to complete the transaction. We saw a cash component in the hostile bid by Goldcorp Inc. (G:TSX; GG:NYSE | Buy rated covered by Tony Lesiak) for Osisko Mining Corp. (OSK:TSX | Hold rated covered by Rahul Paul). That deal was positive for the gold sector because it provides confidence to shareholders that majors can be disciplined enough to make accretive transactions and not always make their acquisitions at the peak of the cycle.

The fall in the junior mining sector over the past few years and the "U-shaped" recovery make this a buyer's market. In part due to the underlying financing risk, developers and explorers are trading at low historic multiples. The potential suitor, whether it be an intermediate or a major, can be very selective, as the ability to "transact" these acquisitions is high. Potential acquisitions will be suitor specific where the nature of the jurisdiction, as well as the suitor's comfort level with developing and operating that asset, will come into play.

Suitors will acquire assets to diversify their asset base and/or add to their development pipeline with inexpensive options. While a few years ago a company would pay up to $70/oz for gold ounces in the Inferred category, currently it may be able to acquire for the same price or less ounces in the reserve category that may already be permitted for development.

TMR: Gold prices in India have dropped from a September high. What is your demand outlook for physical gold in India and China?

JM: Because India suffers from inflation and a weak currency, the local gold price has remained relatively high. India also has imposed duties and restrictions on the importation of gold. Nonetheless, gold still gets into the South Asian nation—albeit with less transparency than a few years ago. The bottom line is that India is buying physical gold because the underlying demand for it remains strong. In 2013, gold continued its flow from West to East with ETF outflows and growth in physical demand by China and India. China is the largest player in the gold market as it has replaced India as the biggest consumer of gold and is also the largest producer.

TMR: How do these trends affect the stock prices of junior gold companies?

JM: The gold price was down 15–30% in various currencies that we track in 2013, mostly due to investment underpinned by ETF outflows. That obviously had a negative impact on our sector. Now, the gold price has been flat to up, but because the betas are so high, the sector as a whole has moved up. Companies that were down over 60% came up almost that much in the month of January, and the gold price itself has not moved that much. We are seeing hypersensitive stocks with high betas to gold react to shifts in the gold price and the re-emergence of an underlying M&A bid for these stocks due in part to the current depressed valuations.

We are looking for companies that may be considered as M&A targets but with management teams that have the capacity to go it alone if the offers are less than attractive. Companies that lack these management teams will have no choice but to take the bid. I encourage investors to seek junior mining stocks where the underlying assets generate double-digit returns (>20%) under the current price environment. Note that companies seeking debt financing for projects are having their assets stress tested to gold prices of US$1,000 to US$1,100/oz.

TMR: Do you have any picks for us?

JM: One company that stands out is Orezone Gold Corporation (ORE:TSX | Spec Buy rated covered by Joe Mazumdar), which has rebranded itself from developing its Bomboré asset in Burkina Faso as a low-grade, open-pit milling operation on the oxide and sulphide ore that is marginal at current gold price levels to seeking to develop an open-pit, heap-leach scenario on the oxide portion of the resource. Orezone released a scoping study to provide the market a preliminary glance at the economics of the heap-leach scenario last week, which generates a >20% return applying our gold forward curve. The bite-sized capital requirement of US$200 million helps provide that level of IRR. The asset is located in a manageable geopolitical jurisdiction that has seen some M&A activity in the latter part of 2013.

Orezone is planning on delivering a feasibility study on the heap-leach scenario in the latter part of 2014. The management team has considerable experience in vending projects to majors in Burkina Faso. Not long ago, the CEO vended the Essakane gold project in the northern part of Burkina Faso to IAMGOLD Corp. (IMG:TSX; IAG: NYSE | Hold rated covered by Tony Lesiak).

TMR: What makes Burkina Faso attractive?

JM: Burkina Faso has 1) a significant geological endowment, 2) a streamlined permitting process, 3) other operating mines and pools of trained workers. The execution risk is not as high as in some West African nations. The combination has attracted some M&A activity in the area in the latter part of 2013. We saw B2Gold Corp. (BTG:NYSE; BTO:TSX; B2G:NSX | Buy rated covered by Rahul Paul) acquire Volta Resources Inc. (VTR:TSX). We saw Centamin Plc (CEE:TSX; CNT:ASX; CEY:LSE | Speculative Buy rated covered by Dmitry Kalachev), seeking diversification from Egypt, acquire Ampella Mining Ltd. (AMX:ASX). In our opinion, Burkina Faso and Ghana are two of the more stable countries in which to look for companies that can attract M&A bids.

TMR: What else is on your radar?

JM: We also favor Castle Mountain Mining Co. Ltd. (TSXV:CMM | Speculative Buy rated covered by Joe Mazumdar). This is an open-pit, heap-leach development play in California's San Bernardino County. I know that some are wary of California, but this is a permitted project that was a producer in the 1990s (Viceroy). Castle Mountain Mining continues to derisk the potential restart and declared a resource with a significant amount of Indicated resource. We anticipate a scoping study out by February 2014. This is a micro-cap play that may represent an easy bolt-on for an intermediate. We find it quite attractive.

TMR: How has the market been treating Castle Mountain over the last period?

JM: We started covering it in October 2013 when it traded at $0.40/share. It has come up 50% since then after it released a resource update in the latter part of 2013. Our current target price of CA$1 is based on its M&A potential and the further derisking to come through the delivery of a scoping study and eventually a feasibility study. Remember the project already has a permit to develop the deposit as it was left on care and maintenance after the previous operation was reclaimed.

I also want to draw your readers' attention to another open-pit, heap-leach project in California (Kern County): Golden Queen Mining Co. Ltd. (GQM:TSX | Speculative Buy rated covered by Joe Mazumdar). It is also a permitted open-pit, heap-leach development play but with 2P reserves known as Soledad Mountain. The company is currently breaking ground on the Soledad Mountain project. The project's proximity to infrastructure such as rail, highway and power are advantages for controlling potential capital escalation.

TMR: Is that an old mine that was producing?

JM: Soledad Mountain was previously an underground mine. Golden Queen has been working to restart it as an open-pit, heap-leach project. It has taken a while to permit because the firm had to deal with changes in the reclamation laws in California, which involve certain levels of backfilling of waste and limits on the mining rate, among other requirements. Golden Queen Mining has joined Castle Mountain and Midway Gold Corp. (MDW:TSX.V; MDW:NYSE.MKT | Hold rated covered by Joe Mazumdar) that have permitted open-pit, heap-leach projects in the southwest U.S.

TMR: Is anything happening for you in the uranium space?

JM: Uranium prices, with spot prices hovering around US$35/pound (US$35/lb) U3O8, have hurt producers. However the deferral of capital projects and prospects for a growth in demand from Asia, specifically from China, are positives. Given the long lead times from exploration to production, we favor junior explorers in the sector within low geopolitical jurisdictions such as the Athabasca Basin of northern Saskatchewan.

We cover Fission Uranium Corp. (FCU:TSX.V | Speculative Buy rated covered by Joe Mazumdar), which we believe has an outstanding project along the southwest margin of the Athabasca Basin. Drilling over the past year or so has returned phenomenal results that indicate a shallow average depth of the U3O8 mineralization. We currently estimate a resource of 34–35 million pounds (34–35 Mlb) grading 3.6% U3O8. It may be fully valued at 34–35 Mlb U3O8, but the attainable goal is to declare a resource greater than 50 Mlb.

Fission just released its first round of preliminary results from its 30,000 meter 2014 drill program, which were excellent. The news flow will keep going until March or April 2014, when the winter program ends, but we should still be seeing assays for another two months following that. Some of Fission's zones of U3O8 mineralization are technically amenable to open-pit mining at a pretty decent grade—well over 1%. Saskatchewan is a very good geopolitical jurisdiction. Fission will, in our opinion, require further derisking in the form of a maiden resource estimate leading to a scoping study to attract any significant M&A bids.

TMR: Are there any other promising uranium juniors operating in the Athabasca Basin?

JM: Our 2014 Junior Mining Sector Watch List is composed of some uranium exploration companies that have management teams with explorationists who have discovered or worked on well-established deposits in the Athabasca Basin. Two companies that we prefer are spinoffs from the merger of Fission Uranium and Alpha Minerals Inc. (delisted). Alpha Exploration Inc. (AEX:TSX.V) is one of them. It is run by the old Alpha Minerals team, who were also part of the old Hathor Exploration Ltd. team. So it has quite an excellent track record. The team recently accepted an award at the Vancouver Mineral Exploration Roundup just last week for discovering the deposit. The other spinoff is Fission 3.0 Corp. (FUU:TSX-V), which has the same management team as Fission Uranium, which, incidentally, won an award. [Editor's note: Ross McElroy Fission Uranium CEO won the Prospectors and Developers Association of Canada 2014 Bill Dennis Award for an important Canadian discovery and prospecting success.] Both of those companies have stellar management teams that have been there and done that in the basin.

And in terms of investing in people who are comfortable where they are working and who have a history of finding the U3O8 mineralization and converting it to resources, I like Forum Uranium Corp. (FDC:TSX.V). The company is run by a management team with a track record of discovering with major uranium players such as AREVA SA (AREVA:EPA).

TMR: I have noticed that there is a bit of a disparity in the stock performance of the uranium industry in the Athabasca.

JM: The disparity between the valuations of producers and explorers is in our opinion due in part to the fact that the Broker Average price is trading around the marginal cost of producing a pound of uranium for some producers. The low spot price, and the long-term price as well to some degree, is a function of a surplus in part resulting from the protracted reactivation of the Japanese nuclear industry. Depending on a company's exposure to spot prices and the quality of the underlying asset, margin squeeze may be an issue.

Uranium explorers, however, are focused on the long term where one seeks the incentive price to bring a project forward. The thesis for the long term is that China is planning on expanding its nuclear capacity. There is a long lead time—10 years—to finding, developing, permitting and actually producing uranium. The time is ripe now for exploring, especially in low geopolitical jurisdictions that offer high-grade deposits such as the Athabasca Basin of northern Saskatchewan. That accounts for the dichotomy between an explorer that's exposed to the long-term incentive price that people are modeling at over $65/lb and producers that are exposed to spot levels of $35–37/lb.

TMR: Why should our readers invest in uranium stocks over the Dow Jones' best performers?

JM: Because if there is a potential shortfall in uranium going forward, investing in explorers is the way to go. The uranium explorers in Saskatchewan did quite well with respect to financing last year, whereas the producing companies suffered. In our opinion, in 2013, uranium was one of the few sectors in the junior mining sector that attracted investor interest.

TMR: Does that analysis apply to gold as well?

JM: In terms of the precious metals sector, we are witnessing a slow rebound from the June 2013 low on the TSX Venture. We urge your readers to follow well-run companies exploring for or developing assets that can generate decent returns in the current gold price environment. These are companies, we believe, that will attract financing. Junior companies with assets that represent out of the money options may continue to suffer if gold remains sideways to down.

TMR: Always a pleasure, Joe.

JM: Thanks for inviting me, Peter.

Joe Mazumdar joined Canaccord Genuity in December 2012 from Haywood Securities, where he also was a senior mining analyst focused on the junior gold market. The majority of his experience is with industry including corporate roles as director of strategic planning, corporate development at Newmont in Denver and senior market analyst/trader at Phelps Dodge in Phoenix. Mazumdar worked in technical roles for IAMGold in Ecuador, North Minerals in Argentina/Chile and Peru, RTZ Mining and Exploration in Argentina and MIM Exploration and Mining in Queensland, Australia, among others. Mazumdar has a Bachelor of Science in geology from the University of Alberta, a Master of Science in geology and mining from James Cook University and a Master of Science in mineral economics from the Colorado School of Mines.